Between the bushfires in Australia, earthquakes in Puerto Rico and political instability across the world, we are becoming increasingly aware of the need to have a ‘safety net’ of funds to sustain us in the event of an emergency.
How much do I need?
The amount of money to cover emergency and unplanned expenses will depend on your individual circumstances, but the general recommendation is to have at least three months’ worth of living expenses set aside in a bank account. It’s important to keep it in cash, so it is easy to access when you need it.
An alternate option is to save three months’ worth of your after-tax salary. So, if you earn $5,000 per month after tax, your emergency fund should be $15,000.
Keep this money separate from your everyday banking account so you are not tempted to access it for any other reason. Some people prefer to hold it in a completely different bank from their day-to-day account so they don’t see it or factor it into their general budget.
Saving this amount of money can be a daunting goal. How do you actually get that magic number in your bank account? Like anything, it’s best to start slowly and take one small step at a time.
Steps to build up an emergency fund
1. Open a new bank account and call it ‘Emergency Fund’.
Option: If you have a mortgage with an offset or redraw facility, you might be able to have the separate emergency funds sitting against your home loan. But strict discipline is required not to touch the emergency account!
2. Work out your monthly expenses. Look at your receipts, credit card statements and bank account statements, then create a spreadsheet or use one of the many online cash flow management tools or apps.
3. Work out your monthly income. Add your after-tax salary to any other income you receive, such as self-employed income, dividends, or rental payments.
4. Subtract the amount you spend each month from the amount you receive. A positive amount is a surplus - which is great!
A negative amount is a deficit, which shows you are living beyond your means (it would be a good idea to reassess your income and expenses). The good news is that you can still save for an emergency, so keep reading!
5. If you have a surplus: transfer the money into your emergency account as soon as you receive your salary. Continue to do this every month until you’ve reached your emergency fund goal.
6. If you have a deficit: in the first month transfer 3% of the salary into your emergency account when you receive your salary. Then gradually increase this amount each month and continue transferring the money until you have reached your emergency fund goal.
It’s important to start with small amounts and only increase when you can. When people transfer more than they can afford, they often have to go back into their emergency account to pay for their living expenses. So, if you start in small increments and increase them each month, it will set up a good saving habit that can be maintained.
7. Do not withdraw from your emergency account, unless it is a real emergency! At the beginning, determine what constitutes an emergency and don’t access the funds for any other reason.
Happy saving!
Learn more of Natallia’s tips on money management at www.truwealthadvice.com.au